These two words – interest rates – has become a part of our everyday life. When purchasing a credit card, applying for a loan or looking for other financial services, you will find that most companies and bankers love to advertise their interest rate. After all, the lower interest rate they offer, the more likely they can entice you to buy their products.
What are Interest Rates?
You know, interest charge is the cost of borrowing money from a lender. And in simple terms, an interest rate is a rate at which the interest charge is calculated. Normally, interest rate is expressed as a percentage of the total amount borrowed.
In the United States, interest rates are decided by the Federal Open Market Committee (FOMC) and the Board of Governors of the Federal Reserve (Board). The former decides on open market operations while the latter determines changes in discount rates based on the recommendations from various Federal Reserve Banks located throughout the country.
Nominal Interest Rates vs. Real Interest Rates
When we discuss interest rate in our day to day conversation, we tend to talk about nominal interest rate that is often used as a nominal variable and not affected by inflation or other factors. It refers to the rate before adjustment for inflation. However, when it comes to real interest rate, things are much different. It has been adjusted to avoid the effect of inflation and reflect the real cost of the money borrowed.
Types of Interest Rates
Interest rates also come in many forms, each of which is quite different from others. And they always vary a lot depending on the type of loans you obtain. Take, for instance, the interest rates of auto loans are likely to be higher than these of your saving account. Generally, there are four common types of interest rates:
• Simple Interest – As the most basic type of interest rate, simple interest is very easy to calculate and understand. It simply overlooks the effects of compounding and is only determined by the amount of principal, the current interest rate and how long it takes to pay off the loan in full.
• Compound Interest – This type of interest rate is widely used by credit card issuers, simply because the more frequently they compound interests, the more money they will be able to earn. Compound interest is calculated based on the original amount of money loaned as well as all interest accumulated during the whole period.
• Fixed Interest – Just as its name dedicates, this kind of interest rate would never change during a predetermined period. On the other hand, the borrower can neither choose a lower rate available at that time, nor change to a floating rate.
• Floating Interest – If you choose a floating rate, the interest charges might go up and down from time to time. One great thing about floating interest rate is that the borrower will be able to change to a fixed interest when the lowest interest rate is available.
Why Interest Rate Rise and Fall?
We all know that interest rate changes at times, but few understand why it rises and falls. In fact, there are only two elements that can influence the interest rate – the demand and supply for money. When the demand of money rises, it pushes up the demand for US dollars and therefore causes an increase of interest rate. The converse is also true. The supply for money, which is determined by the Federal Reserve Bank of the United States, can also affect both short-term and long-term interest rate.
Quick Overview on Different Types of Loans
Nowadays, more and more individuals are turning to various loans for financial assistance while they are planning to buy new homes, cars and other costly things. Loans are really great helpers for people who want to buy cars or pay for expensive things but do not have enough money. The following is a brief overview on some of the famous loans that we may need in daily life.
• Home loans
Home loans are designed for people who are planning to buy new homes, purchase second hand houses or refinance their current home loans. People can also apply for a home loan to build houses on their own. Home loans offer a lot of benefits for the borrowers, including small down payments, competitive interest rates as well as flexible monthly payments options. Home loan interest rates are usually quite low compared with other commercial loan interest rates.
• Car loans
If you want to buy new cars or trucks, you can get huge financial help from various car loans. There are two kinds of car loans available for individuals: fixed rate car loan and adjustable rate car loan. As a result, people can choose from two different types of car loan interest rates as well: fixed interest rate and floatable interest rates. Fixed rate car loan features stable monthly payments while adjustable rate car loans offer floatable monthly payments.
• Student loans
There are also many kinds of powerful loans designed for college students. Students are able to use the money to pay for their college tuitions, living expenses and other expenditures in school. Student loan interest rates are not required during the borrower’s school years. The repayments start after the graduation.
• Boat loans
Boat loans are available to individuals who need economic support to purchase new or used sail boats, yachts, gondolas and other types of loans. Like car loans, boat loans also offer fixed rate and adjustable rate options. Boat loan interest rates are usually determined by the borrowers’ credit rating, loan amount, loan terms and others.